The challenge of innovation in financial services

September 2015 | PROFESSIONAL INSIGHT | BANKING & FINANCE

Financier Worldwide Magazine

September 2015 Issue

Many financial services firms struggle with innovation. Weighed down by the ever increasing burdens of regulation and compliance, it is not surprising that 90 percent of senior leaders we surveyed admitted that they do not have a strong focus on breakthrough or radical innovation. We also found the sector was more inward facing than the seven others we looked at, with leaders tending to look to other financial services firms for inspiration rather than exploring ideas from outside.

While this may be understandable, it is not a healthy position to be in. Rising customer expectations and the emergence of new competitors mean that while ignoring innovation may get incumbent companies through the next few years, it is not a sustainable business strategy for the longer term.

While the overall picture is one of an innovation averse sector, that is not the whole story. Some firms are embracing new ideas and new ways of doing things. Most notably, ‘fintechs’ – small, nimble software-based providers – are disrupting traditional approaches in areas such as international payments and peer to peer lending.

At the same time, some larger banks are using digital technologies to expand their delivery options in areas such as mobile account access. In the insurance industry, many firms are pioneering technologies like in-car telematics to price risk more effectively, and mobile apps to compile inventories of personal property for household insurance policies. So some innovation is happening and delivering results.

Regulation is undoubtedly a significant reason why we are not seeing more of this kind of innovation. Only 35 percent of survey respondents say they are backing high-potential but risky innovations. This was the lowest share among private sector respondents. Nearly half (46 percent) also said their organisations talk more about innovation than actually do it. These responses clearly reflect worries about increasing regulatory risk and compliance burdens.

Another practical problem that hinders innovation is that established banks and insurers are often burdened by decades-old IT systems. These make it much harder to implement new approaches and to do so quickly. In contrast, the fintechs and challenger banks not only avoid the legacy problems, but their business models usually have digital at their core. That will increasingly give them a competitive advantage.

Yet, these are not the only reasons why the sector is not embracing innovation. The problem is a deeper one, reflecting a lack of senior level sponsorship of innovation and an unwillingness to make it a priority. As a result, financial services firms tend to have a layer of management that is uncommitted to innovation and which does not create space to develop new ideas. And where new ideas are developed they often fail to get the right level of ‘can do’ support that is needed.

This lack of innovation has an impact on the bottom line. Our research identified a small group of ‘innovation leaders’ across sectors and of this group 71 percent had seen profitability increase in the last year. It is clear that these innovators are serving their shareholders and customers better and are better placed to win market share.

So what lessons can financial services learn from these leaders? The first is that incremental innovation can lead to big improvements; not all innovation needs to be a radical breakthrough. Indeed, focusing on radical change can end up being a distraction and sometimes it is the small changes that make a real difference to customers.

The next step is to achieve common agreement on what innovation actually means. More than six in 10 respondents (63 percent) complained that people in their firms use the term ‘innovation’ to describe different things. This suggests that senior management has not set out clearly what it wants to achieve. As a result, even though there may be teams of people developing new ideas they will not be clear about what customer need they are meeting or what problem they are solving. Without that clarity, good ideas are likely to fail.

There also needs to be a willingness to take new approaches to managing projects. Currently it can take months just to do a project initiation document, so innovation teams need to be able to adopt more agile techniques that allow them to make things happen quickly.

Another important element in creating a truly innovative culture, that is confident with risk-taking and learns quickly from failure, is to look outside the sector. The very clear lesson from our survey is that the best innovation is customer driven and financial services could learn a lot from other areas, such as retail, on how to respond to that need effectively.

There are some encouraging signs that some firms are beginning to take a more outward looking approach. A number of banks are partnering with tech sector firms, both to encourage the development of new ideas and also to learn how successful innovators bring good ideas to market. Deutsche Bank, for example, plans to open ‘innovation hubs’ in several cities in conjunction with Microsoft, IBM and HCL9. Wells Fargo10 and Spain’s BBVA11 have also looked to the technology sector for potential partnerships.

The final step in becoming an innovation leader is to take a detailed look at the opportunities of digital. This is not easy, given the challenges of the legacy IT systems, but many established banks and insurers have used digital to innovate and realised its potential to take out costs and respond more effectively to customer needs.

It is clear that there are real practical and cultural challenges to overcome in developing innovative approaches in the financial services sector. However, there are also some very significant opportunities for companies whose boards prioritise innovation, bring in external perspectives, focus on the achievable and create a culture that values new ideas. The companies that truly embrace the innovation challenge will be the ones that create sustainable businesses that successfully meet the demands of a more competitive future.

David Troman is head of financial services at PA Consulting Group. He can be contacted on +44 (0) 207 881 3720 or by email: david.troman@paconsulting.com.